By now, you’re probably at least somewhat familiar with the circumstances surrounding the collapse of Silicon Valley Bank (SVB) and the fallout it created for the banking sector. However, we provide some background below.
During the pandemic, SVB saw a huge increase in customer deposits, which nearly tripled from pre-pandemic levels. Some of these deposits were used to provide loans to other customers, but the bank also invested them in U.S. Treasury bonds and other bonds deemed high quality by rating agencies.
When the U.S. Federal Reserve began raising interest rates, the U.S. Yield curve shifted upwards, putting downward pressure on the price of these bonds. Ordinarily, this in itself would not be an issue, as the bank doesn’t have to sell these lower value assets at their new valuation, unless it requires liquidity to meet demand for withdrawals. Yet, that is exactly what happened with SVB: Customer withdrawals rose more than expected, and to meet the need for liquidity, the bank had to sell these bonds at a significant loss.
SVB, in turn, announced that it would need to raise capital. Investors sold off the stock and customers made a run on the bank for their deposits, trying to withdraw $42 billion on March 9. The following day the, Federal Deposit Insurance Corporation took over SVB’s assets. Similar concerns were raised with other banks, including Signature Bank in New York.
One less reported aspect of its failure (including the sale of its UK subsidiary to HSBC) is that it was well rated from an environmental, social and governance (ESG) perspective. A leading data provider gave SVB a good overall ESG rating and an upper end score for governance.
What happened with SVB demonstrates the potential limitations of relying too much on single sources of outsourced, off-the-shelf ESG data. As important a source as third-party ESG ratings and scores are, SVB’s collapse shows that insurers must take greater ownership of the data on which they rely for setting a more sustainable investment strategy.
Beware ‘black boxes’
Currently, a lot of insurers that we speak to are still treating their third party ESG data as ‘black boxes’ where they use the data provided without analysing the methodology used to create the data. SVB was rated well because of its focus on creating initiatives to advance inclusion and opportunity in the innovation economy and its investments in clean energy solutions. SVB was seemingly a sound ESG diversification bet.
Increasingly, using ESG data blindly can be avoided. Insurers can supplement or cross-check rating scores with the expanding range of data available to validate and set ESG strategies. For insurers, there are clear parallels to the rationale for why and what the Prudential Regulation Authority and the Lloyd’s Market already expect with regards to validating the output of external models (e.g. economic scenario generators and CAT models). Stronger ESG investment controls will likely have capital management benefits in the future.
Ways forward could include using more than one data vendor to get different perspectives. This could also go hand in hand with developing an approach for sourcing your own data that more accurately aligns to your specific ESG beliefs, ambitions and targets, such as achieving net zero by a certain date, for example.
The fundamental goal should be to establish a sense check and validate primary data. Other avenues to explore could include periodic deep dives into specific sectors of investment interest to understand what’s driving overall portfolio scores.
Key takeaways
So, coming back to the question of our headline, our main points for insurers to consider are:
- Insurers should take greater ownership of data they’re using to inform investment decisions and manage ESG-related risks.
- It’s also important for insurers to clearly articulate an ESG strategy for their business and create a clear link to how this will apply to their investment strategy, particularly with regards to the implications and potential trade-offs when utilising ESG data.
- Key to doing the above is for insurers to validate and understand the ESG data they’re using, as opposed to relying on a ‘black box’ approach.
- Robust governance around the data insurers use to inform strategy and allocation decisions is an important part of ESG investment strategy. It is important for an insurer to perform due diligence on ESG data when they are using this to inform portfolio allocation decisions and for there to be greater oversight of how their asset managers are making stock selection decisions. This may have brought to light some of the governance concerns relating to SVB.
- WTW are increasingly supporting insurers to consider validation approaches when using third party ESG data and establish governance processes around data used to inform strategic decisions.
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